Trouble Could Be Looming for Puerto Rico Bond Insurers

Moody’s Investors Service on Monday said a new law that provides a path for the financially troubled island commonwealth to restructure the debt of certain public corporations is a “credit negative” for the insurance companies that have guaranteed the bonds.

Assured Guaranty Ltd., MBIA Inc. and Radian Group Inc. have “substantial” exposure to Puerto Rico bonds that in some cases outstrip the assets available to cover unexpected losses, according to Moody’s.

Nonetheless, investors appear to be putting faith in the insurers’ ability to backstop the bonds. A 2024 general-obligation bond from Puerto Rico, which carries insurance from a subsidiary of Assured Guaranty, recently traded at 96 cents on the dollar. A 2028 bond without bond insurance recently traded at about 74 cents on the dollar, according to the Electronic Municipal Market Access website.

Some municipal-bond investors questioned the value of bond insurance following the financial crisis, when bond insurers suffered losses after guaranteeing risky mortgage-backed securities and lost their top credit ratings. The number of new municipal bonds that carry bond insurance has fallen in recent years.

Bond insurers have since found themselves embroiled in the municipal bankruptcies that followed the financial crisis. In April, insurers and Detroit, which filed for bankruptcy last year, reached an agreement in which certain bondholders would end up with a 74% recovery, a higher figure than was originally proposed.

Bond insurance “really gained momentum after New York City’s (financial) problems in the mid-70s,” said Bart Mosley, co-president of Trident Municipal Research, an investment research and strategy firm. “Nobody buys or invests in municipal bonds for excitement. These kinds of events tend to make people look for ways to keep their muni-bond portfolio unexciting, and that’s the whole idea behind insurance.”

MBIA, through its National Public Finance Guarantee Corp. subsidiary, insures $4.8 billion of Puerto Rico bonds, Assured Guaranty backs $5.4 billion through three separate subsidiaries and Radian Group insures $452 million through Radian Asset Assurance, according to Moody’s.

MBIA’s National Public Finance and Assured Guaranty Re Ltd., one of the three Assured subsidiaries, have the highest exposure to Puerto Rico bonds as a percentage of their “qualified statutory capital,” or assets available to cover unexpected losses, according to the Moody’s analysis. National Public Finance insures $4.8 billion but has only set aside $3.3 billion for unexpected losses, a ratio of 145%. Assured Guaranty Re backs $1.5 billion but has only set aside $1 billion, a ratio of 147%.

To be sure, Puerto Rico has not yet missed any bond payments – and even if it did, analysts do not expect it to default on all of its bonds or for it to renege on 100% of its future payments. The new restructuring law only applies to its public corporations, like its electric and highway utilities, and does not apply to its general-obligation bonds or debt backed by sales taxes. Bond insurers are also only responsible for paying back bonds according to the original payment schedule, not all at once, should a default occur.

Stanislas Rouyer, associate managing director at Moody’s, pointed out that most of the insurers’ financial-strength ratings are in the investment-grade category, indicating that the companies have good claims-paying ability.

“The unknown also is: If there is a default, how severe would the loss be?” Mr. Rouyer said. “There’s a lot of open questions at this point.”

Kevin Brown, a spokesman for National Public Finance, said the insurer is confident it could handle any fallout from Puerto Rico.

“In the event that Puerto Rico or any of its public corporations pursue a debt restructuring, National will ensure that its policyholders receive all of their principal and interest payments on time and in full,” Mr. Brown said.

Meanwhile, Assured Guaranty said in a statement that investors who hold bonds that carry its insurance are “protected by our unconditional guaranty.”

A representative for Radian was not immediately available for comment.